Friday, May 4, 2012

These days I keep reading about NGDP targeting, as it keeps being mentioned more and more everywhere. It seems to be another zombie idea taking on more life of its own. It's basically the idea that the current crisis will permanently be solved by the Fed credibly communicating to the people that it will start targeting 4-5% annual growth in nominal GDP level, from here on.

Wow. Imagine, business planners and executives will have no more compunctions about claiming to their investors that they will attain at least 5% nominal revenue growth year in year out. If they don't achieve it via additional sales volume, the Fed is going to make sure they achieve their targets via inflation. Recessions will be a thing of the past. Woohoo! There will be NGDP growth year after year, courtesy of the Fed, regardless of overall business sentiment. Nobody will ever lose again on a business investment, provided everyone invests their money in the most entrenched TBTF companies.

And business investors themselves will have no more worries about their subpar investing prowess. 5% NGDP growth means at least a positive return on their investments, no matter if they put their money in companies run by incompetent managers. If the Fed will work to ensure 5% NGDP growth every year, it wouldn't really mater if the return comes via aggregate demand growth. It can very easily be achieved by asset price appreciation. So fire away, investors. If you don't get the price appreciation via normal market forces, the Fed will come in and goose it up for you.

Now, how again is the Fed supposed to attain this yearly NGDP growth? Via monetary policy? Quantitative easing, Operation twist, swapping Treasuries for reserves? Hasn't this been largely ineffective in reviving demand for the last 2 years? Exactly how is confiscating government treasury assets from the private sector going to make them want to spend more money? And in keeping rates low, or causing more inflation, how is the Fed supposed to convince savers to stop saving, rather than doubling up on saving to make up for the lost yield?

The thing is, monetary policy has overstayed its usefulness as a countercyclical policy. You can only use it so many times to revive an economy from recession. If you don't tighten it back to previous levels, you eventually get to the zero bound, which is where we are. The Fed can't increase rates, but neither can it decrease them below zero. So monetarists have been convincing the fed to buy up other types of financial assets, to lower rates on any and all instruments that are NOT YET at the zero bound. Eventually, where does this take us? They're already proposing the Fed buy up stocks, commodities, and other financial assets.

See, despite all these market distorting moves the Fed has already done, economists are still arguing Bernanke is not doing enough. They continue to encourage him to communicate to the market - that he will do whatever he can to induce inflation until the people do it themselves. The thing is, Chuck Norris may continue promising the people he will beat them up unless they do as he wants, but if Chuck has no arms and legs, people are just going to wonder how he's going to make good on his promise.

And if asset substitution, or buying up financial assets, or further monetary loosening still doesn't work in increasing NGDP? Perhaps the fed can just target inflation directly by regular currency depreciation. The US will then be just another currency manipulator. Will that really get people to start spending their money in the domestic economy, or will it encourage those who can to flee the currency?

It's the height of futility to insist that the Fed be run on autopilot, based on an automatic rule - "Do we have 5% NGDP level growth already? No, buy more assets, yes, stop, higher than 5% already, sell." The thing is, if we insist policymakers to stop thinking and analyzing the economy, and just follow these policy rules automatically, what we'll have is not a clean, well-functioning economy. We'll have instead the economic equivalent or a runaway car whose speed only varies with the slope of the road it's on. It will still go faster and slower, but it won't care who or what is in its path.

PS. That time again. No more posts for me till maybe later this year. Don't worry, the zombies will still be there.

To me it seems if NGDP targeting could be effective, it would be equally effective to just rename Ben Bernanke the "Price Czar" and give him the power to name the price of everything.

Two parties want to make a trade? Call Ben and he'll tell you how much it'll cost. He can do this over and over and write down his logic so that he can then appoint other regional and local Price Czars all following the same logic.

Greg, add it to the long list of titles for Bernanke, but if Sumner's wish is allowed, you'll already know what price Bernanke says each time. Not much need to ask. Not much need to trade for that matter.

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"Conventional approaches, unconventional conclusions" on the global finance and economic issues of the day. Rogue Econ has been a banker and financial consultant in several countries. Welcome to my blog.